What Is a Currency Swap — The 'FX Breakwater' in a Crisis
The 'Korea–U.S. currency swap signed' that always appears in foreign-exchange crisis news. But what is it that, the moment it is announced, the exchange rate drops the next day? Let us unpack the currency swap, called the 'FX breakwater' of a crisis.
What is a currency swap?
A currency swap is a contract in which two countries (mainly central banks) agree to 'exchange each other's currencies at a pre-set rate and return them to the original at maturity.'
The reason a currency swap matters at the national level is that it becomes an 'emergency channel for obtaining dollars in a crisis.'
When a foreign-exchange crisis comes, dollars dry up in the market. Everyone wants dollars, so the won–dollar rate spikes. At this point, if the Bank of Korea sets up a currency swap with the U.S. Federal Reserve (Fed), it can pledge won like collateral and draw in dollars. Supplying these dollars to the market calms the 'dollar shortage' fear.
This swap is different from 'debt.' It is an exchange contract that returns the original currency at maturity, so it is a mechanism to secure dollar liquidity without depleting foreign reserves.
2008: the power of $30 billion
On October 30, 2008, in the thick of the global financial crisis, the Bank of Korea announced a currency swap of $30 billion (6-month maturity) with the U.S. Federal Reserve.
The effect was immediate. On the day of the announcement, the won–dollar rate fell 177 won (about -12.4%) from the previous day (won strength), and the Credit Default Swap (CDS) premium indicating national default risk also fell 1.78 percentage points (about -31.7%).
That the exchange rate moved more than 12% in a single day shows how great the market's fear was, and how strongly the currency swap suppressed that fear.
Source: Namuwiki 'Currency Swap,' Hankyung Economic Glossary 'Korea–U.S. Currency Swap.' Both sources record $30 billion and -177 won on the day.
2020: doubled to $60 billion
On March 19, 2020, when markets froze due to the COVID shock, the Bank of Korea again set up a currency swap with the U.S. Federal Reserve. This time the size was $60 billion, double that of 2008.
Once again the effect appeared. On March 20, the day after the announcement, the continually rising won–dollar rate fell more than 30 won (won strength).
The lesson from the two cases is clear. A currency swap is a psychological and practical safety net that instills market confidence that 'dollars will not dry up' during a crisis. However, this is a temporary emergency measure, and it ends when the maturity arrives. You should also remember that having a currency swap does not make the crisis disappear.
Source: Asiatime 'Korea–U.S. $60 Billion Currency Swap,' Namuwiki 'Currency Swap.' The 2020 swap was extended several times and ended at the end of 2021.
常见问题
Q. How does a currency swap differ from foreign reserves?
Foreign reserves are 'my dollars' that a country has already accumulated. Using them in a crisis reduces the balance. A currency swap is 'an agreed line to borrow dollars from the counterpart country when needed.' Since it is an exchange in which you pledge won and bring in dollars, it is an additional buffer that can supply dollars without directly depleting reserves.
Q. Does having a currency swap mean the exchange rate will not rise?
Not so. A currency swap is only a mechanism to ease the extreme fear that 'dollars will dry up'; it cannot change the fundamental direction of the exchange rate (trade balance, rate gap, business cycle, etc.). Indeed, in 2008 and 2020, the rate calmed temporarily after the swap announcement, but the subsequent trend moved according to various factors.
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📋 结果基于历史数据计算,过去的收益不代表未来的收益。
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